Wall Street Gives Strong Ratings to Deficit Bonds

Wall Street sent an upbeat signal about California’s economic prospects Friday as the state received strong investment ratings on the first of $15 billion in deficit bonds approved by voters last month.

Rating agencies Standard & Poor’s, Moody’s Investor Services and Fitch Ratings all assigned positive ratings to the first $7 billion in bonds promoted by Gov. Arnold Schwarzenegger and the Legislature. The new ratings are far above the rating on California’s general obligation debt, which has the lowest rating of any state in the nation.

“Today’s announcement is a double dose of good news,” state Finance Department spokesman H.D. Palmer said in Sacramento, a day after Thursday’s successful sale of $1.8 billion in lower-rated general obligation bonds.

Saying that “$1.8 billion in California bonds flew off the shelves faster than Lakers playoff tickets,” Palmer said it bodes well for the upcoming bond sales, now set for May 5.

However, the strong ratings for the deficit bonds do not mean that the state’s fiscal crisis is over. The rating agencies all made clear that their decision applied only to this specific bond, not to the state’s overall credit. The bond will be paid off by a specially dedicated portion of the state’s sales tax.

Bond ratings are important because they provide investors with independent evaluations of a government’s or company’s financial strength.

“The double-A ratings by both Moody’s and S & P confirm the belief by the rating agencies that the credit behind the sale is rock solid,” Palmer said. “For state taxpayers, the AA rating is going to mean lower interest costs.”

Standard & Poor’s on Friday rated the deficit bonds AA- on a scale of investment-grade bonds ranging from AAA to BBB-. Bonds with ratings below BBB- are considered junk bonds.

California’s AA- rating means Standard & Poor’s believes the state has “very strong capacity to meet its financial commitments.” Moody’s gave the bonds a similar rating. The Fitch rating was slightly lower.

In assigning the higher rating to the first group of so-called Economic Recovery Bonds, the rating agencies cited the strength of the state’s economy.

Moody’s also noted that the deficit bonds are backed by a quarter-cent sales tax. The money raised from that tax will go directly to repay the bonds and will not flow through the state general fund. As a result, Moody’s said the sales tax is “insulated from the state’s broader budget and financial problems.”

David Blair of Irvine, vice president and senior analyst at Nuveen Investments, said California has one of the world’s largest economies and the deficit bonds are backed by “a solid stream of revenue from the state sales tax.”

The fact that the state general fund cannot borrow against that share of the sales tax “really takes out the main risk ... that is political risk,” Blair said. “That really isn’t a factor here.”

State Treasurer Phil Angelides said the strong ratings coupled with the structure of the bonds would help attract broad investor participation in the upcoming bond sale.

The $7 billion in bonds were originally to have been sold May 4, but that date conflicted with a closely watched Federal Reserve Board meeting scheduled for the same day.

The state is planning to sell another $5.3 billion in deficit bonds with variable interest rates in late May or early June.